What Are the Tax Consequences of Selling Your Home?

With the incredible appreciation in real estate values over the past few years, many people are wondering about the tax consequences of selling their homes. Yes, you may have taxes to pay. But, due to a very generous tax law change in 1997, you can avoid paying taxes on $500,000 worth of gain ($250,000 if you’re single). If you know this new tax law, you can use it to your advantage.

To avoid paying tax, you must have:

  1. Owned and used the home as your principal residence for at least 2 of the 5 years before the sale (the 2-year period does not have to be consecutive),
  2. Not sold another principal residence for at least 2 years and 1 day before the sale, and
  3. Filed a joint tax return in the year of the sale if you’re married. Your spouse doesn’t have to have owned the house, only to have lived in it for 2 of the 5 years.

Do You Owe Any Capital Gains Tax? Calculating the gain isn’t very hard.

Here’s an example:

1. You (an unmarried person) sell your principal home in July of 2005 for $400,000
2. You purchased the home in July 1975 for $92,500
3. Over the years you made improvements totaling $25,000
4. You refinanced the mortgage $1,000
5. At the time of the sale, you pay broker’s fees and settlement costs of $24,000
6. Your total investment in your home is the total of lines 2 through 5 $142,500
7. Before the exclusion you have taxable gains of the sale price (line 1) less your investment (line 6) $257,500
8. You can now take the exclusion allowed by law (up to a maximum of $250,000) – $250,000
9. Your taxable gain is $7,500
10. Your federal capital gains tax is 15% of line 9 $1,125

Most states will also tax these capital gains. Having a mortgage does not affect your taxable gain.

The Old Rules

Under the old rules you could avoid paying tax on the sale of your home if you bought a new home more expensive than the old one. After age 55 you could take a one-time exclusion of $125,000. Forget these rules; the new ones are more beneficial.

Selling Two Homes

As usual with tax law, the fine print is more complicated. This is especially true if you are planning to marry and both of you own homes. You’ll need to do some careful planning so that you don’t sell both homes within a 2-year time period and end up paying taxes on one of the sales.

Before any life transition it’s always a good idea to seek the advice of a fee-only financial advisor. BWFA is ready to help you take advantage of tax laws and avoid common mistakes.